The Importance of Being Schmucky

Everyone’s got a theory.

I’m fairly sure the equity markets going to decline sometime in the near future. (The price to earnings ratio of the S&P 500 is much higher than average, which has historically predicted lower returns going forward, (although that may change if the market continues to pull back.)

Warren Buffett almost always thinks bonds are a bad bet, and equities a good one.

Value investors think that the market under values” bad companies”which is exactly why you should buy them: they’re on sale!

Growth investors believe you should be investing in companies whose profits you believe will grow by leaps and bounds. After all who doesn’t want to see their stock value double or triple or quadruple like a young microsoft?

It seems that we are all hardwired to believe stuff. Unfortunately, it also seems that we are also hardwired to overvalue our own opinions.

This is where the whole concept of “the behavior gap,” comes in.  This term is meant to explain why most investors underperform the indices that they are investing in.  “The behavior gap,” is just another observation that people are irrational, and that in investing, this irrationality costs money.
Which is one of the wonderful things about passive investing.

It’s an admission of ignorance.

If you’re a passive investor (like me) what you’re basically saying is “I’ve got lots of opinions, and even though I want to act on them, I know they’re probably not worth much. So I’m going to just keep on having opinions, and I’m going to keep on ignoring them by betting on the whole market. After all I know I’m just another dumb schmuck.

Conversely the active investor is saying”I’ve got an opinion. And I’m sure it’s right. I’m sure it’s righter than all the rest of you people with your wrong opinions. I’m so sure it’s right I’m going to put my nickel down on my opinion. And I’m going to win Baby. And you are going to lose.

So if we were picking between passive Guy or active guy for a movie role, I think we’d all go with active guy. He’s cool. He’s confident. He trusts his gut, and he’s not afraid to take risk.

He’s James Dean playing chicken in Rebel Without A Cause. He’s Rambo taking it to the jungle. He’s Bruce Willis in Die Hard. He doesn’t play by your rules. But he plays to win.

We don’t play by your rules….

Passive guy? Not so much. He’s more like Jonah Hill in Moneyball. He’s an accountant tapping on his calculator and playing the odds even though he’s very afraid that he might be wrong.

But here’s the thing, eight times out of 10 the passive investor is right and the active investor is wrong.

Not in their opinion. Their opinions are equally inane. But in their actions, where it counts. Where money grows or shrinks. Where winning and losing takes place.

You see Passive Guy’s irrationality is irrelevant to his investing strategy. If his instincts are right? He bets on the market. But if his instincts are wrong? He bets on the market.

That cool cat Active Guy, though, his irrationality costs him money. When his gut feeling is right, he gets extra returns (minus the increased trading costs.) but when his gut feeling is wrong, he loses money (and additional training costs.)

So there’s a lot to be said for just admitting that you’re a schmuck.

Because you are, you know. You’re a schmuck. (It takes one to know one.)

Neither one of us has a clue what’s going to happen with the market tomorrow.

And if you don’t believe me you should write down your prediction for the market’s performance the next day, every day for a month. See how often you’re right.

And once you’re convinced you’re a schmuck, you can continue having your silly opinions. As you can see from the second paragraph in this post, I’ll still have mine.

And you can talk about them at cocktail parties if it makes you feel good.

Or you could just have a glass of wine and spend time with your family and write your blog. It really won’t matter one way or the other.

All in all It’s pretty relaxing being a schmuck (if you know you’re a schmuck.)